Study: Ethanol not a major factor in reducing gas prices

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If you have stopped at a gas station recently, there is a good chance your auto has consumed fuel with ethanol blended into it. Yet the price of gasoline is not substantially affected by the volume of its ethanol content, according to a paper co-authored by an MIT economist. The study seeks to rebut the claim, broadly aired over the past couple of years, that widespread use of ethanol has reduced the wholesale cost of gasoline by $0.89 to $1.09 per gallon.

Whatever the benefits or drawbacks of ethanol, MIT’s Christopher Knittel says, price issues are not among them right now.

“The point of our paper is not to say that ethanol doesn’t have a place in the marketplace, but it’s more that the facts should drive this discussion,” says Knittel, the William Barton Rogers Professor of Energy and a professor of applied economics at the MIT Sloan School of Management.

The 10 percent solution?

The vast majority of ethanol sold in the United States is made from corn. It now constitutes 10 percent of U.S. gasoline, up from 3 percent in 2003.

It is another matter, however, whether that increase in ethanol content produces serious savings at the pump, as some claim. Knittel and his co-author, economist Aaron Smith of the University of California at Davis, contest such an assertion in their paper, which is forthcoming in The Energy Journal, a peer-reviewed publication in the field.

The claim that ethanol lowers prices derives from a previous study on the issue, which Knittel and Smith believe is problematic. That prior work involves what energy economists call the “crack ratio,” which is effectively the price of gasoline divided by the price of oil.

The crack ratio is something energy analysts can use to understand the relative value of gasoline compared to oil: The higher the crack ratio, the more expensive gasoline is in relative terms. If ethanol were a notably cheap component of gasoline production, its increasing presence in the fuel mix might reveal itself in the form of a decreasing crack ratio.

So while gasoline is made primarily from oil, there are other elements that figure into the cost of refining gasoline. Thus if oil prices double, Knittel points out, gasoline prices do not necessarily double. But in general, when oil prices — as the denominator of this fraction — go up, the crack ratio itself falls.

The previous work evaluated time periods when oil prices rose, and the percentage of ethanol in gasoline also rose.

But Knittel and Smith assert that the increased proportion of ethanol in gasoline merely correlated with the declining crack ratio, and did not contribute to it in any causal sense. Instead, they think that changing oil prices drove the change in the crack ratio, and that when those prices are accounted for, the apparent effect of ethanol “simply goes away,” as Knittel says.

To further illustrate that the previous study was touting a correlation, not a causal relationship, Knittel and Smith conducted what are known in economics literature as “antitests” of that study’s model. By inserting unconnected dependent variables into the model, they found that the model also produced a strong correlation between ethanol content in gasoline and, for instance, U.S. employment figures — although the latter are clearly unrelated to the composition of gasoline.

The previous work also claimed that if ethanol production came to an immediate halt, gasoline prices would rise by 41 to 92 percent. But Knittel does not think that estimate would bear out in such a scenario.

“In the very short run, if ethanol vanished tomorrow, we would be scrambling to find fuel to cover that for a week, or less than a month,” Knittel says. “But certainly within a month, increases in imports would relax or reduce that price impact.”

Informing the debate

The differing assessments of ethanol’s impact have garnered notice among economists and energy policy analysts. Scott Irwin, an economist at the University of Illinois at Urbana-Champaign who has read the paper, calls it a “convincing and compelling” rebuttal to the idea that expanding ethanol content in gasoline drastically lowers prices.

“The paper dispensed once and for all with that conclusion,” Irwin says. Still, he adds, there remains an open debate about the marginal effects of ethanol content in gasoline, and more empirical work on the subject would be useful.

“A case can be made that it can be a positive few cents,” Irwin says, adding that “reasonable arguments can be made on either side of zero” regarding ethanol’s price impact. In either case, Irwin says, his view is that the effect is currently a small one.

Knittel has posted, on his MIT Sloan web page, a multipart exchange between himself and Dermot Hayes, an Iowa State University economist who is a co-author of the prior work. After an initial finding that ethanol reduced gasoline prices by $0.25 per gallon, Hayes and a co-author produced follow-up studies, examining about a decade after 2000, and arrived at the figures of $0.89 and $1.09 per gallon, which gained wider public traction.

Knittel acknowledges that policy decisions about gasoline production are driven by a complex series of political factors, and says his study is not intended to directly convey any policy preferences on his part. Still, he suggests that even ethanol backers in policy debates have reason to keep examining its value.

“Making claims about the benefits of ethanol that are overblown is only going to set up policymakers for disappointment,” Knittel says.

Comments

Dr.A.Jagadeesh

October 10, 2013

Ethanol is subsidised in US because it is mostly made from Corn and sugarcane. In the debate on Food Vs Fuel,fortunately one can go in for production of Biofuel from Agave which is a care-free growth plant. There are multiple uses of Agave too. Developing countries can go in for mass cultivation of Agave which is regenerative and CAM plant too. Also there is Opuntia another care-free growth plant for producing power through Biogas route.

Dr.A.Jagadeesh Nellore(AP),India

charles langer

October 14, 2013

If one does a simple comparison on E85 verses gas used in flex vehicles at fueleconomy.gov I have yet to find a vehicle that does not cost at least 20% more to use E85 rather than gasoline. What is the true gain in the 10% if any when the 10% only delivers 7% when figures ethanol energy loss? One also has to weigh in energy in production of it. The net gain at most would be 2% at best. In an energy tight environment does it make sense using the energy to make it for so small a gain. This program is corporate welfare for the farmers at the expense of the consumer in a time when oil production here is a all high and rising. Its time for a non bias study on the need for corn ethanol if any. This mandate calls for steady increases in volumes used per year at a time when the program really makes little sense. Since 2008 livestock levels are the lowest they have been since 1952 and annual food has gone up more than $2000 a year for the average family. Remove the mandates, allow free choice.

Graham Adsit

October 15, 2013

Christopher Knittel's underlying assertion is that a lower cost equivalent product (after BTU normalization) does not lower price point. That is illogical.

Second assertion is that crack spread is quality independent - i.e. octane has no utility. That is illogical.

RIN detached neat ethanol is selling for near $1.30 ($1.95 GGE) a gallon FOB November 13 delivery. Leave the RIN in and we still see $2.32 GGE. Premium rack price near $3.00.

Dr. Knittel, I do not agree with Du et al. But cannot agree with you either. Please explain how low cost and high volumes do not lead to low prices in an inelastic product.

dwight schrute

October 28, 2013

What must also be considered is what is the alternate to ethanol.

Refiners must produce rbob to blend with ethanol to make the fungible product we all use in our cars. Without going into the details of how they operate this means they have to reduce the use of low cost light components such as butane and pentane

They would operate differently if they didn't have to use ethanol and you really have to look at ethanol vs it's competition not the end use product

The alternate includes how they operate refinery and the investments they make

You can find times when ethanol was significantly cheaper and significantly MORE expensive.

It will probably be a wash

Noot

August 31, 2014

How may passes by a farm tractor from start to finish to till, pesticide, harvest and then prep for next year adding whatever needed to the soil where weak spots were in the crop. Not to mention the truck and trailer transporting the corn to the ethanol processing. Running on diesel at a dollar or more a gallon than gas prices. Someone smarter than I do the math please